The Internal Revenue Service last week delivered both good news and bad news to academic medical centers and teaching hospitals on a closely watched multimillion-dollar payroll tax issue.
The IRS' actions will severely limit the number of medical residents working at hospitals who can be exempt from paying Social Security and Medicare payroll taxes. At the same time, officials said they would soon unveil a program that will allow some hospitals and residents to obtain refunds of such taxes.
The news came in a set of proposed regulations from the IRS that was published in the Feb. 25 Federal Register. The regulations affect what are known as Federal Insurance Contribution Act collections, or FICA for short, and what it takes to qualify for student exemptions. The IRS also said that within 90 days it would announce details of a settlement resolution program that could enable some hospitals and residents who have already filed for FICA tax refunds to obtain them.
The federal government requires employers to pay 7.65% of employee wages or salaries and deduct an equal amount from the employee's paycheck to fund Social Security and Medicare. Starting in 1997, after the University of Minnesota prevailed in federal court in Minneapolis, some teaching hospitals and academic medical centers sought to exempt resident physicians from FICA under the student-exemption clause and began seeking refunds of taxes (Feb. 16, p. 26). As of 2000, some 228 organizations, mostly hospitals and healthcare organizations, had requested more than $162 million in refunds, according to the General Accounting Office.
The IRS is suing an unknown number of hospitals that received refunds that the IRS said it sent out "erroneously." Sources close to the dispute said the number of healthcare organizations and the potential size of the refunds have grown significantly since 2000.
"Nobody really expected these regulations at this time," said Richard Speizman, a tax partner with accounting giant KPMG who has advised a coalition of hospitals and associations seeking FICA refunds. "But the IRS has made up its mind on its position-that is that most medical residents aren't students."
The hospitals argued that payment for the work residents perform in hospitals is a stipend, not a salary or wage, and the hospital training is a necessary part of physician education. Recent IRS guidance has suggested that full-time medical residents working at schools, colleges and universities qualify for the student exemption. However, a number of hospitals that are not owned by, but merely affiliated with schools, colleges and universities, have filed for refunds. Mount Sinai Medical Center in Miami Beach, Fla., which received $2.3 million in refunds, was subsequently challenged by the IRS in a case slated for trial in April in U.S. District Court in Miami.
The proposed IRS regulations specify whether organizations qualify as a "school, college or university" based on their functions and could end up shutting out teaching hospitals like Mount Sinai from the exemption. The new regulations also define whether a resident is a student or an employee by examining on a case-by-case basis whether "education or employment is predominant in the relationship" between the resident physician and the organization. The regulations consider residents to be employees if they regularly work more than 40 hours per week, are professional employees, are eligible to participate in retiree benefit programs and need a license to work in the field.
Mount Sinai General Counsel Arnold Jaffee said he remains optimistic about the hospital's chances in court. He pointed out that the proposed regulations are not retrospective and that refund requests filed before Feb. 25 are not liable to interpretation under those rules.
The resolution program will establish a process for those institutions seeking refunds to see if they qualify and, if so, to determine how much they should receive, KPMG's Speizman said.
Public comments on the regulations are due May 25 and will be aired during a June 25 public hearing.